Two Small Banks With Big Appeal

By

David Englander

August 3, 2013

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The Nasdaq Index of community banks has shot up 30% this year, with improving credit metrics, the potential for industry consolidation, and the possibility of higher interest rates all contributing to investor enthusiasm.

United Financial, a New England bank, is benefiting from good loan growth. Its shares are inexpensive relative to peers.
Mark Murray/Landov

Despite the move, value can still be found in the small-banking sector.
United Financial Bancorp
(ticker: UBNK) is a case in point: The thrift, based in West Springfield, Mass., trades for a sizable discount to peers.

United Financial traded Friday at $15.60 a share, equal to 120% of tangible book value of $13 a share. According to Matthew Breese, an analyst at Sterne Agee, comparable banks trade for 150% of tangible book.

The gap could narrow in the next 18 months, as improving profitability helps lift United Financial's stock. In the meantime, investors can collect a healthy 2.8% dividend yield. At 1.35 times tangible book, United Financial shares would be worth $17.55.

United Financial operates 37 branches in Massachusetts and Connecticut, and has $2.4 billion of assets. The bank completed a second-step conversion to public ownership in 2007, selling all its shares to the public.

United primarily makes residential and commercial real-estate loans, which account for 70% of its $1.9 billion loan book. Commercial, construction, and home-equity loans comprise the remainder. In the June quarter, nonperforming assets were just 0.65% of total assets, and net charge-offs were 0.11% of average loans.

Loan growth has been good, as the bank has benefited from its strategy of expanding into new markets. In the June quarter, loans grew 1.2%, driven by commercial and residential real-estate business. Commercial real-estate loans grew by 2.3%, and the pipeline remains strong. United has plenty of excess capital to keep up its loan growth, with tangible common equity of 10.6% of tangible assets.

United Financial Bancorp

Recent Price

$15.60

52 Week Range

$16.47-$13.73

Market Value

$309 million

Est 2013 Revenue

$92 million

Est 2013 Net Income

$20 million

Est EPS 2013

$1.00

Est EPS 2014

$1.13

Price/Tangible Book Value

120%

Dividend Yield

2.8%

Source: Bloomberg

Last year the bank generated a 7% return on tangible common equity, and this year is expected to generate an 8% return, as management works to cut costs and improve efficiency. Expenses were $16.3 million in the June quarter, but could fall to $15 million in the third quarter as FDIC premiums and marketing costs decline. Management believes it can lower the efficiency ratio, a measure of a bank's costs to its revenue, to less than 65%, down from 70% in the latest reported quarter.

Analysts expect United to earn $20 million, or $1 a share, this year, on revenue of $92 million. In 2014, earnings could increase to $1.13 a share, reflecting lower costs.

In the past four years, United has been acquisitive, buying two other banks. It snapped up Commonwealth National Bank, of Worcester, Mass., in 2009, and New England Bancshares, of Enfield, Conn., in 2012.

In an interview, CEO Richard Collins said New England Bancshares was a "natural fit," and that so far "the acquisition is going quite well, and is on track to become a successful part of our franchise."

Further acquisitions are unlikely in the near future. Said Collins: "Our top priority is to become as efficient and profitable as possible. But we're not ruling out the possibility of another acquisition, if an opportunity were to appear."

United could find itself as a takeover candidate. Given the overbanked New England market and higher costs that banks are incurring from new regulations, consolidation is likely to continue in the region.

One logical suitor is
Berkshire Hills Bancorp
(BHLB), a larger Pittsfield, Mass.-based bank with plenty of branch overlaps. In a deal, it's likely that United would fetch a premium.

Second Step

Investors Bancorp
(ISBC) is another bank worthy of investor attention. Shares of the Short Hills, N.J.-based thrift, with $13 billion in assets and 100 branches in New Jersey and New York, are up 39%, to $22.20 on Friday since we wrote a positive story on the bank last August ("A Stock to Bank On," Aug. 20, 2012).

The shares still look attractive, due mainly to the bank's ownership structure; it is partly mutually held, and partly publicly traded. Investors Bancorp is now the largest bank in the country with such a dual-ownership structure.

The division of ownership could be resolved in the next few months with an announcement of a so-called second step conversion, whereby the bank would sell the rest of its shares to the public. Anticipation of the deal has driven the stock up, but more gains could follow.

Matthew Kelley, who covers Investors for Sterne Agee, noted in a recent report that the continuing rally in bank stocks suggests Investors could command a premium valuation in its deal. It could come to market at 100% to 106% of tangible book value, and raise more than $1 billion. At the midpoint of this range, he estimates fully converted tangible book value at $20.50 a share.

Based on that estimate, the stock trades for 108% of tangible book. According to Kelley, fully converted and overcapitalized peers trade for 135% of tangible book.

Investors management has proved a good steward of capital, as the bank successfully levered the proceeds of its initial offering in 2005. In the next couple of years, as management deploys the new capital in a similar fashion, Investors stock could gain 20% or more. At $27.50, it would trade on par with peers.

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Two Small Banks With Big Appeal

The Nasdaq Index of community banks has shot up 30% this year, with improving credit metrics, the potential for industry consolidation, and the possibility of higher interest rates all contributing to investor enthusiasm.

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